Gary Harrell on Government Spending & National Debt

For many years people said that places in Europe like Sweden were the best models of government, but since the president start[ed] trying to pass [programs] like theirs, you have been critical of him. Can you help me understand why you do not think it's right? And please do not just talk like a[n] angry Republican. (Shenada M.)

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The Scandinavian countries of Europe are often praised as among the best places to live on the planet, thanks in no small part to the omnibus social programs intended to enrich the quality of the lives of citizens in these countries. But all of that comes at a very high price; in fact, debt levels in these countries are stratospheric. In Norway, for example, the government’s spending is 40% of GDP, and the national debt is roughly 202% of GDP. In Finland, government spending amounts to 47% of GDP, while national debt is at 220% of GDP. For Sweden, the situation is not comparatively better; while the government spends at 52.5% of GDP, its national debt hovers around 264% of GDP. And in Denmark, where government spending is 51% of GDP, the national debt is a whopping 316% of GDP.

To cope with the ravenous demands of their social programs, and in order to service seemingly insurmountable sums of debts, these countries have adopted some of the toughest tax regimes on the planet. In Norway, the top federal tax rate stands at 47.8%, and with that, individuals can expect to pay a value-added tax and net wealth tax, in addition to local taxes. Finland is a little better, with its top federal tax rate at 30.5%, along with a value-added tax, inheritance tax, and capital gains tax (also not including local taxes). Meanwhile, Sweden has a top tax rate of 57%, and beyond local taxes, it also levies a valued-added tax, a property tax, and a capital gains tax on its citizens. And debt-laden Denmark may be worst of all, with its 59% top tax rate on individual income and a bevy of other taxes including a value-added tax, a vehicle tax, and 8% health tax.

It seems that, in order to provide a better quality of life of their citizens, these nations had to go rather deeply into debt – and now those citizens are expected to cover the costs.

The Rest of Us

Before the ardent capitalists and free-marketers haul off and snicker about the absurdity of it all, they would do well to look at what is going on in their own countries. Indeed, some of the rest of us are not faring much better than our Scandinavian friends. In fact, we need only take the case of two of Europe’s leading, western nations – the United Kingdom and Germany – to illustrate this point, but no assessment would be complete, of course, without a look at the United States.

As David Cameron assumed office as the conservative Prime Minister of Britain, he did so with a pledge to reign in his nation’s spending. Before his countrymen, in early June, Cameron spoke these words about the debt situation facing the United Kingdom: “The overall scale of the problem is worse than we thought.” It is not an exaggeration. The totality of government spending in the UK amounts jumped from approximately 39% of GDP to over 45% of GDP from 2008 to 2009, and now it stands at nearly 46%. What’s more, in order to conduct all of this spending, British leaders borrowed tremendous sums. The national debt of the UK is an almost-inconceivable 425% of the country’s annual economy output. Cameron’s austerity measures may help to reign in spending going forward, as well as to shave a bit off the top of that pile of debt. But revenues are needed in the form of taxes to make any significant dent. To that end, for now, the United Kingdom has a tax system that resembles its European counterparts: a 40% top tax rate on individual income, along with a value-added tax, an inheritance tax, and a capital gains tax.

Meanwhile, on the Continent, Germany, an industrial and export powerhouse, suffers from problems very similar to everyone else. The national government’s spending in Germany is at 44% of GDP, and its national debt is at 182% of the country’s annual economic output. Many pundits and German voters believe that this problem could bring down the stalwart Chancellor Angela Merkel and her coalition government. In fact, while Merkel strives to make budget cuts, tens of thousands of Germans have taken to the streets in protest over the austerity measures that come in the face of bailing out other European nations. For the individual German citizen, the top tax rate stands at 45% (5% more than his British counterpart), and there is a 5.5% solidarity surcharge tacked onto the income taxes, along with the country’s value-added tax and capital gains tax.

Across the pond known as the Atlantic Ocean, the United States, which is largely thought of as less socialist than most European nations, cannot help but to be a big spender, as well. Government spending in the US is over 44% of the nation’s GDP. Republicans might be quick to claim that such large amounts of spending are the hallmark of their Democratic counterparts, but that is not the whole story. In fact, in the Reagan years (including the four years served by George H.W. Bush), government spending as a percentage of GDP climbed by 3.22%, and under George W. Bush, it went from 33.38% in 2001 to 37.12% in 2008. (We actually saw an appreciable decrease in the government spending during the two terms of William J. Clinton.) While the two sides continue to bicker over how to right the country, the national debt stands at 96.5% of GDP. To service the debt and keep the government functional, in 2011, Americans will see a top federal tax rate of 39.6%, and the federal government also levies an inheritance tax and capital gain tax on individuals. So far, any talk of new income taxes, or even an additional valued-added tax, is not coming from the reigning Democrats in Congress or from President Barrack Obama – and that is just fine. Given the mood of most Americans, particularly following the stimulus package and health-care reform, any talk of new taxes is likely to enhance the current firestorm threatening to jettison them from power.

Falling Short

For these nations, all of whom craft large annual budgets and carry awesome amounts of debt on their national balance sheets, economic growth is vital. That is because growth, among other things, translates into new tax revenues, which are used to service existing debts, as well as to finance public-sector operations. Without growth, a nation could fall short on its commitments to constituents and debt holders, alike. It seems that both Prime Minister Cameron and Chancellor Merkel understand that logic well enough, as they fight to reign in their governments’ spending in the face of very pale growth. Unfortunately, the same cannot be said for President Obama, who, though giving tacit commitments to spending cuts, has presented nothing in the form of a real plan. For the United States this is troubling, if for no other reason than because the rate of economic growth has been seriously less than the rate at which the debt of the nation has grown. In fact, while the economy has grown at an average of 2.78% per year for the last five years, the growth rate of the national debt has been 9.27% per year – and it has grown at that pace since 1970.

Contrary to what some might want to believe, a national government, just like any person or any business or any household, cannot go on borrowing and spending indefinitely. It also cannot afford to enact new entitlement programs, or sustain existing ones, without someday having to recognizing the need to conform spending to the strictures of reality. If it tries to continue too far down the path of indebtedness, the market will decide its fate. Investors will either demand even greater returns qua yields in exchange for the purchase of the nation’s bonds – or they will stop buying, or start selling, them, altogether. And with that, the nation’s currency is likely to take a thumping. All of this will occur because the markets will have lost confidence in the nation’s ability to service its debts, even though that nation’s leaders might go on insisting that the situation is not as bad as it seems.

This story has played out just this way in Greece, and the market fears have moved across the Europeans Union. More telling examples of a modern sovereign debt crisis can be found in Brazil (mid-1980’s), in Mexico (1994), in Russia (1998), and in Argentina (2001). For each of these crises, the overarching ingredients for disaster are the same: high volumes of government spending financed on borrowed money far beyond the amount of annual tax revenues, and a moment of truth that unravels investor confidence. For so many caught up in the tumult, things do not end well, as they watch years of savings and investments simply disappear in the blink of an eye.

So far, a crisis has been averted in the United States, as well as throughout much of Europe, and that is a good thing. But no one, particularly no one in leadership, should take an easy sigh of relief yet, because, for as long as our debt levels remain so colossal, the specter of crisis looms near.

“Mini-Crisis”

The average working person and, in some cases, even the average businessperson may be excused for not fully understanding the roles that government spending and sovereign debt play in their own lives, but as many Argentines, Russians, or Icelanders can assure you, ignorance is not bliss, especially if you live in a country with both high deficit spending and even higher national debt.

So what exactly are the consequences of so much debt? Well, short of a full-blown debt crisis, large amounts of national debt can still impact the daily lives of a nation’s citizens. For the sake of this document, we will assess the impact in two distinctive categories of events: the first are the market events, and then come the political events.

In the first set of events, as stated above, when borrowing continues unabated, investors become cautious. These are the market events. The investors demand greater incentives to lend the borrower money – in this case, higher yields on the national bonds. Those yields have a very direct influence on the interest rates for everything else, from mortgages to cars to commercial loans and so on. If the investors’ appetites for the nation’s debt is very low or nonexistent, it is not uncommon to see them look elsewhere, investing their money in safer bets. That could mean the demand for the heavy-borrowing nation’s currency will also drop, and a falling currency (relative to other currencies) raises the prices of imports and increases the cost of doing business aboard.

After the loss of investor confidence, the rise of interest rates, and the devaluation of the currency – the second set of events, the political events, begin. Here, leaders of the nation will try to impose stability under the guise of saving the economy. The leaders will finally discover the courage to make drastic cuts in government spending, but they will also have to make an effort to raise taxes, in order to generate more revenue to replace some of what could not be borrowed. Meanwhile, with both the costs of imports and the cost of capital now higher, and with government providing less support and private wealth diminished, consumer and commercial spending are likely to decline. That means those businesses best equipped to survive will have to look abroad for new markets for their wares, but they will thankfully have a weaker currency on which to compete in the global economy. And back at the capitol, which is probably now reeling from broad voter discontent, some political leaders will surely propose very wrong-headed measures that amount to nothing more than capital controls and protectionism, in order to, as they will claim, save domestic jobs. The ironic consequence of this, though, is that the very possibility of capital controls will drive away most foreign investors, particularly the ones who saw this as an opportunity to buy new assets and who are sorely needed to reinvigorate the economy. Also, as the Smoot-Hawley bill proved in 1930, tariffs on one side beget more tariffs on the other. The effect of a trade war on the domestic businesses trying to sell abroad will be damaging. In the end, so much wealth and so many jobs will be lost that voters will deem their leaders incapable of meaning the nation’s needs, and they will cry out for regime change. They likely will get it…

For a leader like President Obama, this scenario, one depicting a sovereign debt “mini-crisis” in the United States is far more likely than a full-blown one, but it would still most certainly result in the end of his presidency. Sadly enough, taking the fall for decades of bad governance would not have to be the case, if he exhibited the courage to address government spending and the national debt before the markets do it for him. Instead, President Obama has pushed in the opposite direction, spending even greater sums than his predecessors, and adding to the national debt, until just recently, without the slightest acknowledgement of its existence. If investors tire of the rapacious borrowing and spending in the same way many American voters have, then history will record his presidency as anything but successful.

And as for Europe’s nations, particularly the Scandinavian nations, the peril is the same. Britain’s Prime Minister Cameron and Germany Chancellor Merkel may not make the largest reductions to their own countries’ indebtedness, but if they remain steadfast, they will set those countries on a proper corrective course. And the British and Germans can be forerunners to their fellow Europeans, as they lead by example and attract more of the world’s investors along the way.

Freedom

Over thousand years ago, on the very same continent, Publilius Syrus, one of Rome’s most celebrated writers, said, “Debt is the slavery of the free.” His words could not be more profound or painful in their accuracy; yet, they are so often negated.

It should be remembered that freedom is independence. Freedom is self-determination, self-reliance, and self-preservation. Freedom is the constructive use of one’s own productive skills to shape one’s own destiny. But we are not free if our continued economic vitality is taxed excessively to sustain an impractical largess of public programs that know no end. We are not free if our livelihoods, our savings, and our futures can be easily wiped away, because our governments have chained our very existence in the shackles of endless debt. That indebtedness places a free man in the service of a master other than himself. Therefore, any man or woman who values his or her freedom, who takes pride in his or her labor, and who struggles to realize his or her dreams would be well-served to understand the perils created by such debt and spending and, from there, demand better from those who are called to lead our nations.

--Written by Gary C. Harrell